Finance

When a bitterly divided Congress failed to pass an Economic stimulus bill last fall, many predicted the recession would only worsen. But while few were paying attention, government spending surpassed the amounts envisioned in the stimulus measure, exceeding what even the most vociferous advocates wanted. The unexpected surge – along with the remarkable strength in consumer spending – helps to explain why the recession, to nearly everyone’s surprise, has been so mild and may beending.

The mood was much different last fall. Anticipating harder times, Democrats and Republicans pushed for an additional $80 billion to $100 billion in federal outlays. While they agreed on this goal, they deadlocked over how to allocate the money. Democrats wanted the government to spend nearly all of the money, while the Republicans emphasized new tax breaks for business and consumers, not outright spending. Despite the bill’s failure – a severely watered-down version finally passed this month – government outlays rose sharply in response to dozens of uncoordinated decisions and fortuitous windfalls. The surge, which started in October, has continued into this month at a rate of more than $100 billion, new government data suggest. And income tax cuts that went into effect at the beginning of this year are expected to provide a further lift to the economy.

“You can reasonably argue that the recession, which seems to have ended, came to an end because of aggressive government spending,” said Mark M. Zandi, chief economist at Economy.com, a forecasting and data gathering firm. Some of the stepped-up outlays, of course, went to the military and to pay for domestic actions to fight terrorism in response to the Sept. 11 attacks. Significantly more, however, was delivered in the form of increased spending on highways, school construction, Medicaid, unemployment insurance and numerous Municipal projects.

After shrinking last summer, the American economy reversed course and grew from October through December at an annual rate of 1.4 percent. The results of aggressive Government spending – not only at the federal level, but among states and cities as well – accounts for much of the swing from contraction to expansion, even without adding in the tax breaks, the Bureau of Economic Analysis reports. The rise in government outlays, along with the remarkable bounce back in consumer spending after Sept. 11, more than offset declines in other sectors, particularly business spending on new equipment, offices and factories.

Will that last? The hope is that the momentum from consumers and government, two powerful engines of demand, will restart business investment and the recovery will be on its way. The danger, however, is that both may falter before the economy picks up sufficient speed. Mortgage refinancing, rising wages, bargain prices, falling energy costs, tax cuts and rebates, rock-bottom Interest rates – all these have sustained consumers through The recession, despite rising indebtedness. And while this year’s income tax cuts promise to provide more stimulus, most of the other supports show signs of fading. Something similar may be happening to government spending – not at the federal level, where the outlays in response to terrorism seem open-ended, but in the states and cities.

Most experts thought that spending at the state and local level would decline as tax revenue fell during the recession. Reflecting this view, the advocates of a stimulus package pushed last fall to include subsidies that would permit states and cities to keep up their spending. To nearly everyone’s surprise the states and cities found ways to sustain their spending anyway, despite balanced-budget laws that require them to keep spending in line with revenue. This rear-guard resistance, however, seems likely to give way by early summer when many new budgets, mandating cuts, go into effect for the fiscal year 2003.

“You can expect the drop in state and local spending that did not occur last fall to begin to occur now,” said Kevin Carey, an analyst at the Center on Budget and Policy Priorities. So far, good luck and ingenuity have helped the states and cities dodge that bullet. There was, for example, a windfall in 1998 and 1999 from a federal excise tax on gasoline and autos. That tax, earmarked for the states, produced an unanticipated $10 billion during those boom years that is now being spent to build and repair highways. “It takes time to arrange to pour concrete,” said William Hoagland, a senior staff member of the Senate Budget Committee. There were other tactics for sustaining spending, despite falling tax revenue. Reserve funds, built up to record levels during the boom, have been drawn down. Some spending cuts have been announced and then postponed. And some states and cities have simply crossed their fingers.

Consider Vermont. Faced with rising Medicaid costs and payments to needy families, cities in Vermont have drawn $750,000 from a $2 million account set aside to clean up oil spills. “The gamble is that there won’t be a spill into our rivers,” said Steven Jeffrey, executive director of the Vermont League of Cities and Towns, “or a leak from some aging storage tank, and we won’t have to repay the money.” The fortuitous surge in federal spending showed up in a report this month from the nonpartisan Congressional Budget Office. The report compared federal outlays in the first five months of the current fiscal year – October through February – with spending in the same months in the previous year. Outlays were up 13.1 percent, double the usual percentage increase. Over 12 months, the additional surge, if it continues, will total $106 billion, or the equivalent of about one full percentage point in economic growth, even before counting spillover effects.

“If you want to argue that we have had stimulus, without stimulus legislation last fall, I think that is certainly the case,” said Barry B. Anderson, deputy director of the Congressional Budget Office. The jump in federal spending has been most noticeable in rising outlays for the military, for internal security -particularly at airports – and in subsidies to airlines to keep them flying. New York has also received help paying for the cleanup at ground zero. But an even greater amount has shown up as spikes in federal pending for Medicaid, for unemployment insurance, and, among other things, in outlays for education and highways. Some of this money was channeled to the states, which accounted for slightly more than half of the fourth-quarter surge in overall government spending. The states and cities got their fattened subsidies after all, without having them mandated in an economic stimulus package, as the advocates had demanded last fall.

The subject did not even come up in the brief debate this month over the very watered-down economic stimulus bill that Congress passed and President Bush signed. It will cut some business taxes and add only $8 billion to government spending, all of it for extended unemployment benefits. Economists and budget analysts are just beginning to offer explanations for the unanticipated part of the surge in government spending since October. The Medicaid increase, for example, is attributed mostly to rising costs for prescription drugs and to growing participation in a health insurance program for poor children. And stepped-up spending for education has helped. “There are a multiplicity of reasons,” said Richard Kogan, a senior fellow at the Center on Budget Priorities, “for this extraordinary increase in government spending.”